Atlanta Fed President Dennis Lockhart touched on some important topics in today’s speech in New Orleans.  Specifically, he highlights the two primary issues of the day: inflation and end demand.  He said:

On inflation:

“To sum up, I don’t see inflation as much of a current worry. If anything, there is a small risk of deflation that must be monitored. Limited inflation allows focused attention to recovery and growth, which I’d like to turn to now.”

Of course there is no inflation.  We are more Japanese than most would like to admit.  Most would like to make this recession out to be far more complex than it really is, but the truth is that a balance sheet recession comes down to one primary factor: high private sector debt levels result in a desire to REDUCE debt rather than INCREASE debt.  This makes monetary policy futile and creates an inherently deflationary environment as debt destruction results in reduced spending levels and lower velocity of money.  I’ve been beating this drum for several years now, but the argument is only just beginning to gain traction.

On end demand:

“Here’s a key point about these contributors to recovery—each could be transitory. The economy has not yet arrived at a state where healthy and sustainable final demand is underpinning growth.”

Again, the two are interconnected.  Deflation remains the greater threat due to the above commentary.  Aggregate demand is weak because the private sector has been crushed under the burden of excessive debt.   By my calculations this environment is likely to persist well into 2012 as there remains almost $1.3T in excess debt.  The private sector is not ready to run with the baton. Aggregate demand is likely to remain subdued until the private sector has been “cleared”.

Despite these two facts the rest of Lockhart’s commentary is fairly rosy – something that just doesn’t add up when you consider the current direction of monetary and fiscal policy….

Cullen Roche

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